On September 5, 2022, the central bank announced that with effect from September 15, 2022, the required reserve ratio for foreign exchange deposits of financial institutions would be reduced by 2 percentage points, that is, the required reserve ratio for foreign exchange deposits would be reduced from the current 8% to 6%. This is the second time that the required reserve ratio for foreign exchange deposits has been lowered since May 15 this year (by one point). We have the following understanding:

The reduction of the required reserve ratio for foreign exchange deposits is mainly aimed at stabilizing the exchange rate. Since August, due to the spread of the epidemic, weak domestic growth expectations and narrowing interest rate spreads between China and the United States, the RMB exchange rate has adjusted rapidly, and the spot exchange rate of the US dollar against the RMB has depreciated from 6.75 at the beginning of August to 6.93 on September 5.

Judging from the historical law, the two-way fluctuation of the RMB is relatively obvious in terms of reasonable equilibrium, and the range of annual rise and depreciation generally does not exceed 7%. As of September 5, the dollar has depreciated by 8.2% against the midpoint compared with the last trading day last year, and the emergence of a stable exchange rate is politically reasonable.

Lowering the required reserve ratio for foreign exchange deposits can, on the one hand, directly release foreign exchange funds of about US $19 billion, thereby increasing the supply of foreign exchange in the interbank foreign exchange market and easing the appreciation of foreign exchange and the depreciation of the RMB; second, it will send a policy signal to stabilize the exchange rate and revise the depreciation expectations of the market.

According to the regulations on the Administration of Foreign Exchange Deposit reserves of Financial institutions, foreign exchange deposit reserves are deposits deposited by financial institutions with a certain proportion of their foreign exchange deposits with the people's Bank of China in accordance with the regulations. The required reserve ratio of foreign exchange deposits is the ratio of the foreign exchange deposit reserves deposited by financial institutions with the people's Bank of China to their absorption of foreign exchange deposits.

The central bank made four adjustments to the required reserve ratio of foreign exchange deposits from 2005 to 2021, all of which were raised, basically against the background of appreciation pressure on the RMB exchange rate. The downgrade is the second in history. The last downgrade, on May 15, 2022, mainly pointed to the rapid devaluation of the RMB exchange rate, this time with a similar purpose, but also in response to the recent rapid devaluation of the RMB exchange rate.

From the perspective of historical law, the two-way fluctuation of RMB at a reasonable equilibrium level is relatively obvious, and the change of exchange rate fluctuation is basically less than 7%.

2007, 2008, 2017, 2020 and 2021 are the years in which the RMB exchange rate has appreciated more in the last 15 years. The exchange rate appreciation in these years is 6.46%, 6.43%, 5.81%, 6.47% and 2.29%, respectively. 2015, 2016 and 2018 are the years in which the RMB exchange rate depreciated more, and the exchange rate depreciated by 6.12%, 6.83% and 5.04% respectively. As of September 5 this year, the RMB has depreciated by about 8.2% compared with the end of 2021, and the emergence of a stable exchange rate policy is reasonable.

The reduction in the required reserve ratio of foreign exchange deposits will support the RMB exchange rate from two levels: (1) releasing more foreign currency supply and affecting the supply and demand of foreign currency in the interbank foreign exchange market, according to the estimate of US $953.7 billion in foreign exchange deposits at the end of July 2022, lowering the foreign exchange deposit reserve ratio by two points will release about US $19 billion in supply; (2) send out the signal of policy to stabilize the exchange rate and correct the depreciation expectation of the market.

In addition to stabilizing the exchange rate, another effect that can be achieved by policy operations is to stabilize foreign currency loans. In our previous report "how to look at the July Social Finance data", we mentioned that foreign currency loans continued to grow negatively after April this year, with a year-on-year increase of 282.9 billion yuan in the past five months, which is one of the important constraints to the improvement of the credit environment.

Lowering the foreign exchange deposit reserve ratio is similar to lowering the RMB deposit reserve ratio, which can alleviate the liquidity constraints faced by banks in issuing foreign currency loans, encourage banks to increase foreign currency loans from the policy side, and stabilize foreign currency loans and credit environment.

From March to July this year, new foreign currency loans were 23.9 billion yuan,-76 billion yuan,-24 billion yuan,-29.1 billion yuan and-113.7 billion yuan, respectively, with year-on-year increases of 4.3 billion yuan, 48.8 billion yuan, 24.7 billion yuan, 99.2 billion yuan and 105.9 billion yuan, a total increase of 282.9 billion yuan.

One concern in financial markets this year is that maintaining external equilibrium will restrict the room for steady growth of monetary policy, especially the use of price-based instruments. The policy combination of lowering the required reserve ratio of foreign exchange deposits by MLF and LPR+ since August shows that in the face of the pressure of internal and external equilibrium, the central bank seems to adopt monetary policy to maintain internal equilibrium (stable growth) and exchange rate policy to maintain external equilibrium (stable exchange rate and capital flows).

At the regular policy briefing of the State Council on September 5, Vice President Liu Guoqiang also pointed out that "as an economic power, China should independently implement monetary policy based on its own national conditions."。

We understand that when narrow liquidity is still wide and banks' expansion credit is less constrained by liquidity, subsequent monetary policy may continue to focus on reducing lending rates and easing demand constraints. In this process, if the external equilibrium is affected, there is still adjustment pressure on the exchange rate, and the exchange rate policy that the central bank can use, in addition to the foreign exchange deposit reserve ratio, it also includes the use of counter-cyclical adjustment factors, adjustment of foreign exchange risk deposit reserve ratio, strengthening cross-border macro-prudential management and so on.

At the regular policy briefing of the State Council on September 5, Vice President Liu Guoqiang pointed out that monetary policy serves the economy, the economic fundamentals of different countries are different, the financial environment is different, and monetary policy should of course be different. this is just like different people wearing different shoes, different economies should implement different monetary policies.

As an economic power, China should implement monetary policy independently based on its own national conditions. After the outbreak of the epidemic, China effectively co-ordinated epidemic prevention and control and economic and social development, took the lead in achieving positive economic growth, made it possible and necessary for our country to implement a normal monetary policy, persisted in not flooding and issuing more money, did not implement unconventional monetary policies, and did not empty the toolbox.

Therefore, at present, there is still plenty of room for monetary policy in China, and there is no shortage of policy tools, neither price tools nor quantitative tools.

In the next step, we will adhere to a prudent monetary policy, make effective use of policy tools, take into account the relationship between stable growth, stable employment and stable inflation, and deal with various risks and challenges.

The RMB exchange rate stabilized immediately after the required reserve ratio for foreign exchange deposits was cut by one point on May 15. However, it is worth noting that in addition to the exchange rate policy, the domestic economy has emerged from the epidemic and growth expectations are heating up; overseas recession is expected to heat up, US debt peaked and fell in mid-June, and the interest rate gap between China and the United States tends to stabilize.

After this exchange rate policy operation, the economic trend is also more critical. It is true that some positive factors are emerging after mid-August, one is the gradual decline of the high temperature, the other is the intensive landing of a new round of stable growth policies, such as the confirmation of the special debt limit of 500 billion yuan, and the addition of 300 billion yuan of policy-oriented development financial instruments. Real estate "one city, one policy", policy supervision "flexible use of phased credit policy and guarantee building special loans" and so on. If there is a marginal improvement in the economy in mid-to-late September, this round of exchange rate stabilization will be more sustainable.

The adjustment of the required reserve ratio of foreign exchange deposits has a certain coordinate significance to the short-cycle exchange rate. After the required reserve ratio of foreign exchange deposits was cut by one point on May 15 this year, the RMB exchange rate stabilized immediately. This time, the required reserve ratio of foreign exchange deposits has been reduced more sharply, and the exchange rate has been stabilized more vigorously, which should also be helpful to the short-term change of the exchange rate.

However, it is worth noting that the last phased stabilization of the exchange rate was accompanied by other factors. First, the domestic epidemic has been further controlled after mid-May, the economy has improved month-on-month, and domestic growth is expected to rise; second, overseas recession is expected to heat up, 10-year US debt began to peak after mid-June, and the interest rate gap between China and the United States is no longer widening.

At present, there have been some good changes in the expectation of domestic growth: first, as the high temperature gradually passes, the gap in power supply will ease, and residential activities and outdoor construction will increase; second, the fiscal gap will be further filled. On August 24th, the National standing Committee confirmed the special debt limit and added 300 billion new policy development financial instruments. Third, the real estate policy continues to heat up, reducing the 5-year LPR on the 22nd, emphasizing the "one city, one policy" on the 24th, and Baojiaolou is also in the process of implementation.

At present, there is still uncertainty to be further observed is the domestic epidemic situation.

On the overseas side, the pricing of recession expectations has temporarily come to an end, and tightening expected pricing has made a comeback as the dominant logic of US bond interest rates, which is still being interpreted, and there is still uncertainty about when it will change again.

In the follow-up, if the domestic epidemic and overseas tightening are expected to moderate marginally, the probability of another phased stabilization of the exchange rate this round will be significantly increased.

From the empirical data, there is a certain correlation between the exchange rate and the stock market. On the one hand, the exchange rate depreciation trend usually corresponds to the stage of slowing down real growth, and corporate profit expectations are generally in the adjustment period; second, under the exchange rate depreciation trend, there are exchange losses on foreign capital holding RMB assets, and foreign capital inflows will slow down in stages. From the latter logic, if the exchange rate tends to be stable, it is a positive message for the stock market.

Assumed risk:Macroeconomic downward pressure is higher than expected; liquidity environment is higher than expected; overseas recession risk is higher than expected; overseas monetary policy spillover risk is higher than expected; global financial market and exchange rate market volatility risk is higher than expected.